HKSCC NEXT GENERATION (NG)

RISK MODELS

April 2018

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Background

HKSCC NG Margin Model Framework

Market Impact (NG Margin Model)

Margin Calculation Flow

5 Margin Calculation Examples

Agenda

6 Operations under New Margin Model

BACKGROUND

BACKGROUND

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Background

Adopt pragmatic yet effective measures to strengthen

risk management in response to the 2008 global

financial crisis

Amongst the foremost CCPs in Asia to implement

initial margin in the cash equity market

Framework

Single rate margin model

Introduction of dynamic Default Fund (DF) component

Background

Meets evolving international regulatory standards

Improves safety, integrity and efficiency of HK

securities market

Framework

More “risk-based” approach i.e. margin requirements

and DF to better reflect the risk exposure of CP’s

portfolio

onwards……………

..…. Risk Management Reform 1 HKSCC NG Risk Models

A continuous effort to improve compliance to international regulatory standards

and the protection in HK securities market

2009 2008 2012 2019 2017 2018 2016 …. ….

Global

Financial

Crisis

G20 Meeting &

Mandate

• Publication of

IOSCO(1) PFMI(2)

• EMIR Regulation

Publication of IOSCO

Further Guidance

Introduction of margin

multiplier

Interim Enhancement

Note 1: International Organization of Securities Commissions

Note 2: Principles for Financial Market Infrastructures

Evolution of Global Regulation and HKSCC Risk Management

5

Enhancements are methodology-centric

and most existing settlement and operation arrangements remain unchanged

Initial Margin

Single margin rate based on Hang Seng

Index (HSI) applied to all securities

No risk offset among securities

Stress Testing

Up and down scenario applied to all

securities to generally cover systemic risk

Current HKSCC Model HKSCC NG Risk Models

Initial Margin

Margin requirement based on individual

stocks volatility

Allow risk offset among selected securities

(see HKSCC NG IM model framework for

details)

Stress Testing

Multiple product-specific scenarios applied

to each security

HKSCC NG Risk Model Framework

Key Enhancements

HKSCC NG MARGIN MODEL

FRAMEWORK

HKSCC NG MARGIN MODEL FRAMEWORK

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Flat rate on higher of Long / Short CNS

positions (current HKSCC methodology)

Two-tier : Hang Seng Composite Index (HSCI)-based

Non-

Constituent

Tier

(Tier N)

Primary Tier

(Tier P)

HSCI Large Cap and Mid Cap constituent stocks

Covers securities which rank in the top 95% of the

total market capitalization

All Equity indices ETFs

As at Mar 2018 :

Includes ~450 instruments

Covers 74% of the total market turnover

Contains all instruments not in Tier P (e.g., GEM stocks,

small / micro cap stocks, etc.)

Operationally easier to adopt by CPs given the similarity

to current single margin rate model

As at Mar 2018:

Includes ~1,950 instruments

Cash Equities and

Structured Products (SP) Handling

Portfolio Margining and subject to minimum

margin level

Includes SP with Tier P underlying or HSI/

HHI Index

Two-Tier Initial Margin Model Approach

A hybrid approach consists of portfolio margining (for Tier P) and flat rate (for Tier N)

Subject to SFC’s final approval

8 (1) Uses Exponential Weighted Moving Average (EWMA) for calculation

Subject to SFC’s final approval

Initial Margin Model Summary

1. Scope

3. Margining

Position

5. Margin Period of

Risk (MPOR)

2. Margin

Calculation

4. Implied Volatility

Modelling

Tier P

Instrument specific

Results of 1,000 recent days(1) with the

weight of 75%

Results of identified stress dates with the

weight of 25%

All long and short Continuous Net

Settlement (CNS) positions

1 day with liquidation risk add-on for illiquid /

concentrated positions

Yes

Tier N

One margin rate based on a reference

market index for all non-Tier P instruments

Higher of long / short CNS positions

1 day with liquidation risk buffer

Nil

Current HKSCC approach

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Liquidation Risk Add-On for Tier P Sub Portfolio

Achieve better compliance to international standards

Rationale • Additional margin in the margin model framework to cover the additional cost of portfolio handling in

the default management process

Mechanism

Liquidation Risk Add-On for Tier P

• Primarily reference the bid ask spread and daily trading volume of instruments

• Add-on will be triggered when CNS positions exceed the defined thresholds

Liquidation Risk buffer for Tier N

• Covered by the flat margin rate

MARKET IMPACT

(NG MARGIN MODEL)

MARKET IMPACT

(NG MARGIN MODEL)

11 Subject to SFC’s final approval

2015 Q1 - 2017 Q3 (Proposed vs. Current)

Market Impact (1): Margin Requirement of the Market

The proposed model effectively captures the risk in heightened volatility period

and in general provides margin savings for the market

(HK$, Million)

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17

12 Subject to SFC’s final approval

% Observations for all CPs during 2015 Q1 - 2017 Q3 (Proposed vs. Current)

Market Impact (2): Frequency and Magnitude of IM Change

In general, margin will decrease or remain unchanged; most of the margin increases are insignificant

Increase 8%

Saving 12%

No change 80%

14%

86%

36%

64%

Modest (< $10m)

Material (> $10m)

CALCULATION FLOW AND EXAMPLES

OF INITIAL MARGIN

MARGIN CALCULATION FLOW

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Tier P Margin Calculation Flow

Portfolio Margin Calculation Methodology

Portfolio Margining

Risk Offset

Same as current HKSCC

methodology

Higher Flat Rate

15 (1) Tier P margin is subject to minimum margin level

(2) Tier N portfolio IM is subject to margin multiplier and the multiplier is determined by the magnitude of a Clearing Participant’s back-testing deficit

Next Generation Margin Calculation Flow

Tier N

Margin Requirement for CP’s portfolio

Final Portfolio Margin

Margin Calculation Methodology

Final

Portfolio IM Tier P

Portfolio IM(1)

Tier P

Liquidation Risk

Add-On

Tier N

Portfolio IM

including

Liquidation Risk

Buffer(2)

Similar to current HKSCC methodology

16 (1) Tier P margin is subject to minimum margin level

Tier P Margin Calculation Flow

Margin Calculation Methodology

Step 1

Scenarios P&L

Security 1

Security 2

Portfolio

Security N

P&L 1 P&L 2 … P&L 1000

P&L 1 P&L 2 … P&L 1000

P&L 1 P&L 2 … P&L 1000

…

Aggregation of P&Ls per Scenario

Historical days

Day 1 Day 2 … Day 1000

…

Loss estimated

from historical

days

Step 3 Tier P

Portfolio IM(1)

Loss estimated

from historical

days 75%

Loss estimated

from identified

stress dates 25%

Step 2 Loss estimated

from identified

stress dates

Stress Scenarios P&L

Security 1

Security 2

Portfolio

Security N

P&L 1 P&L 2 … P&L x

P&L 1 P&L 2 … P&L x

P&L 1 P&L 2 … P&L x

…

Aggregation of P&Ls per Stress Scenario

Identified stress dates

Stress Date 1 Stress Date 2 … Stress Date 𝒙

…

CALCULATION FLOW AND EXAMPLES

OF INITIAL MARGIN

MARGIN CALCULATION EXAMPLES

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Stock Code L/S Quantity Tier Market Value Stress Date 1 Stress Date 2 … Stress Date 𝒙

0003.HK Short 21000 P (364,980) (19,209) 9,121 … -

0005.HK Short 7500 P (503,250) (6,894) 4,534 … (2,794)

0016.HK Long 2200 P 262,460 13,634 (6,480) … (2,716)

0388.HK Long 2000 P 351,600 14,449 (1,157) … -

0700.HK Long 2000 P 261,400 31,457 (3,528) … 4,559

Aggregated Stress Scenario P&L for Tier P at Portfolio Level 33,437 2,490 … (950)

Stock Code L/S Quantity Tier Market Value Day 1 Day 2 … Day 1000

0003.HK Short 21000 P (364,980) 392 337 … 341

0005.HK Short 7500 P (503,250) 283 (5,496) … (6,452)

0016.HK Long 2200 P 262,460 (3,610) (2,367) … 4,553

0388.HK Long 2000 P 351,600 (3,129) 1,152 … 7,038

0700.HK Long 2000 P 261,400 (2,404) (108) … 2,672

Aggregated Scenario P&L for Tier P at Portfolio Level (8,468) (6,482) … 8,152

(1) Tier P margin is subject to minimum margin level

*All above figures are hypothetical for illustrative purpose only

Balanced Portfolio with 5 Tier P stocks and 5 Tier N stocks

Numerical Examples of Calculation of IM Requirement (1)

Tier P Margin Calculation Methodology

Step 1

Historical Days

Step 2

Identified Stress Dates

Step 3

Average loss of the worst 6 days

= HK$ 8,125

Tier P

Portfolio IM(1)

Loss estimated

from historical

days 75%

Loss estimated

from identified

stress dates 25%

HK$ 8,125 HK$ 10,000 HK$ 8,594

Average loss of the worst 2%

dates = HK$ 10,000

19 (1) Tier N portfolio IM is subject to margin multiplier

(2) Tier P margin is subject to minimum margin level

(3) Tier P liquidation risk add-on is not triggered in this example

*All above figures are hypothetical for illustrative purpose only

Portfolio with 5 Tier P stocks and 5 Tier N stocks

Numerical Examples of Calculation of IM Requirement (2)

Tier N

Margin Requirement for CP’s portfolio

Final Portfolio Margin

Tier N

Portfolio IM

including

Liquidation

Risk Buffer(1)

12% Flat Rate

Margin Calculation Methodology

Stock Code L/S Quantity Tier Market Value

0057.HK Long 70000 N 143,500

0709.HK Long 5000 N 21,050

8103.HK Long 20000 N 33,800

Long CNS 198,350

0715.HK Short 100000 N (77,000)

0855.HK Short 23000 N (119,600)

Short CNS (196,600)

Higher of Long/ Short Tier N CNS

Tier P

Portfolio IM(2)

Tier P

Liquidation Risk

Add-On(3)

Tier N

Portfolio IM

including

Liquidation Risk

Buffer(1)

HK$ 32,396 Portfolio

Margin

HK$ 8,594 HK$ 23,802

20 *All above figures are hypothetical for illustrative purpose only

General Relationship Between Portfolio Characteristics and IM Requirements

Characteristics

Directional Portfolio

Consists of net long or net short positions

Limited scope for risk netting at portfolio level resulting

in higher margin requirement

Concentrated Positions with Volatile Stocks

Lack of diversification in portfolio and concentrated in volatile stocks (e.g. small and mid-cap stocks)

Higher IM to reflect the riskier nature of high volatility

stocks

Examples

Directional Portfolio

IM Requirement

NG Risk Models: HK$ 132,658

Portfolio with 85% concentration in 1 volatile stock

IM Requirement

NG Risk Models: HK$ 40,770

Diversified Portfolio

Consists of balanced long / short positions or hedged positions (e.g. Structured Products (SP) vs. underlying, ETF vs. underlying)

Lower IM due to portfolio margining Portfolio with SP hedged against underlying

IM Requirement

NG Risk Models: HK$ 2,143

Balanced Portfolio

IM Requirement

NG Risk Models: HK$ 32,396

OVERVIEW OF OPERATION IMPACT

AND MITIGATION

OPERATIONS

UNDER NEW MARGIN MODEL

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Operations under New Margin Model

Other Features

Mitigation of

Potential Impact

■ HK$5 million margin credit Margin credit of

HK$5M will continue

Collection and refund

process

Operational

Impact Funding

■ CP’s internal funding requirement could fluctuate as IM of the portfolio is

calculated based on the risk of the portfolio

■ Relevant settlement reports will still be available via existing CCASS

■ Timing of most existing operations remains unchanged

■ Excess margin is refunded on the following day

■ Default Fund (DF) collection/ refund period will follow current practice

■ Reports content and frequency will be adjusted to promote transparency

of new models Reports

Margin Simulation

Tools (see next slide

for details)

■ Facilitate CPs’ internal processes related to risk control and margin

payment / collection

Specific Stock

Collateral (SSC) or

Specific Cash

Collateral (SCC)

■ CNS stock positions covered by SSC or SCC are exempted from initial

margin calculation

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Overview of Margin Simulation Tools

Features CPs input trades via a web-based Graphical User Interface (GUI) or spreadsheet upload

Results can be download from web portal for CP’s internal risk control purpose

■ Allow CPs to replicate and simulate margin requirement for existing portfolio and hypothetical trades

■ To facilitate CPs’ internal processes related to risk control and margin payment / collection under a

relatively sophisticated margin model Purpose

HKEX Web based GUI Input / upload hypothetical trades

or clients’ portfolio

Simulated margin requirement

Web Server

Calculate simulated margin

requirement

Option 1: Web Portal

The above proposed structure will be subject to discussion / confirmation with HKEX system vendor

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Overview of Margin Simulation Tools

Features HKEX provides RPF (at granular risk parameter level) for each stock and structured product

CPs download and use the RPF for estimating margin requirement and risk management of house, affiliate

or client portfolios on the next day

Option 2: Risk Parameters File

Risk Parameters File

(Download from HKEX Website)

Simulated

Margin

requirement

The above proposed structure will be subject to discussion / confirmation with HKEX system vendor

25 (1) http://www.hkex.com.hk/Services/Next-Generation-Post-Trade-Programme/

Market Communication Timetable

2Q18 1Q18 3Q18 4Q18 1Q19 2Q19

Meetings with CPs (Mar-Jun)

Post new model info pack/FAQ on HKEX website and on-going update (starting Apr – )

MR (TBC)

• Seminars to all CPs and vendors (Apr)

• Workshops on technical & operational details (Jun; Sep-Oct)

Target

Launch CP

System

Readiness

Market Communication Channels

• One-on-one meetings

• Seminars

• Technical & operational workshops

• Information publish & update on HKEX website(1)

System Readiness

• Target to publish technical specification in mid-2018

• Target to provide at least 6-month period to CPs for system readiness

We encourage each CP firm to appoint designated contacts to work with us closely

in ensuring a smooth implementation

“Margin simulation test” (4Q18; 3-mth period; TBC)

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1. Go to https://www.hsi.com.hk/HSI-Net/

2. Click on “Benchmark Indexes” tab and then click on

Hang Seng Composite Size Indexes

3. Click on Constituents tab and select the LargeCap,

MidCap and SmallCap in the dropdown box

Two-tier : Hang Seng Composite Index (HSCI)-based

HKEX will update Tier P stocks list for margining on a regular basis and

notify CPs about the change beforehand

Contact us at

margin_modelling@hkex.com.hk

for questions/feedback